Fair or Equal - Planning for Non-Participating Children in Family Farm or Ranch Ownership Transition

THE COUNSELOR

Volume 5 • Issue 2 • February 2015

The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. In this month’s issue, we will discuss planning for non-participating children in family farm or ranch ownership transition. If you are interested in learning more about the ideas and processes discussed in this newsletter please contact us for an initial consultation.

When planning for the transition of ownership on the family farm or ranch, one of the major hurdles is always how to appropriately deal with the children who are not participating in the operation. Rarely does a family present where all of the children desire to work in the farm or ranch operation and when they do that has its own set of challenges. When discussing succession planning in the context of a family farm or ranch, a good working definition is: a process of decision making that:

Protects the ongoing viability of the agricultural operation

Provides for the orderly transition of the agricultural operation to new ownership

Preserves family harmony

An attempt to make things “equal” by bringing the non-participating family members into ownership of the family farm or ranch can be a recipe for disaster.

The Basic Problem

A farm or ranch family usually involves a child or children working in the farm or ranch operation who want to continue as the operators after the retirement or death of the parents, and children living away from the farm or ranch who are not interested in working in the farm or ranch operation. The non-participating children may desire to have an ongoing ownership interest generated from nostalgia, but more often prefer “their share” of the inheritance. The participating child is primarily concerned with securing ownership of the land and production assets necessary in running the farm or ranch operation and participating in the growth that takes place. Participating children will want to see capital re-invested in the operation, while non-participating owners will want to see a realization of the value of the asset owned through distributions of cash. This sets up paradigms of ownership that are inherently at odds.

Fair vs. Equal

Often the departing generation will express a desire to be “fair” with their children. In the parent’s mind this equates to an “equal” distribution to each child. For example, Bob and Jane have the following assets:

Farm Operation: $2,000,000.00

Home: $175,000.00

Other Investments: $500,000.00

Bob and Jane have four children: Emma, Grace, Henry and Sam. Emma loves the rural lifestyle. Her and her husband, Frank, have stayed and worked on the family farm for twenty years. Grace, Henry and Sam all have jobs and spouses that have taken them away from farm with no intention of coming back to work. If Bob and Jane give the farm to Emma she will inherit $2,000,000 while Grace, Henry and Sam will share $675,000.00. This may be difficult for three non-participating children to understand. If the split of the assets is done in equal shares, however, each person receives and inheritance valued at $668,750.00. While this may appear more “equal” at first glance, is it really? If Emma is given control of the farming operation, the value of this asset is really illusory. Grace, Henry and Sam can never realize its value. It just looks good on paper. In fact, now that the non-farm assets are being split four ways instead of three they actually receive less in useable assets.

Additionally, equal doesn’t take into account the sweat equity Emma has put into the farm. Nor does it consider her lost opportunities or lower wages received. In dealing with this issue, the goal should really be equitable – not equal.

What Are Your Options?

Because the cash flow of the farm or ranch is often insufficient to fund a fully proportionate inheritance to the non-participating children, you will be forced to make difficult decisions if you want the operation to pass successfully to the next generation. But remember, cash to the non-participating child in an amount much less than the proportionate value of the farm or ranch may in fact produce more income than the participating child will receive from the operation.

In the first instance, the inheritance to the non-participating children should come from assets that are not central to the farm or ranch operation and/or from the purchase of the farm operation by the participating child at a pre-determined price. A common way of providing an inheritance for the non-participating children is through the purchase of life insurance on the parent’s life. In the case of a sale to the participating child, the premiums paid on the life insurance may involve a smaller outlay of cash than installment payments on a promissory note. The policy should be of a permanent nature as opposed to term to ensure it will be there when needed. Consideration should be given to a joint life policy on both parents as premiums can be substantially less than on a single life policy. A major drawback to life insurance is the considerations of age and health in determining the premium. Therefore, there is no time like the present to look into the availability and cost of life insurance.

Conclusion

As with most complex problems there is rarely a simple solution. However, changing your mindset from one of equal to equitable will open doors that have previously been closed. It will also create a framework for success in your succession planning.

This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.